Handlowy to a Buy From

Banks | Poland Recommendation upgrade

 We upgrade our rating for Handlowy to a Buy from

Handlowy Neutral with TP down to PLN 81 from PLN 86  We lift our EPS estimates by 4% in 2018E and cut by Buy (from Neutral) 3% in 2019E TP: PLN 81

20 June 2018 08:00

30.10.2015 High yielding bank with strong earnings momentum. Company data Rating Buy Upgrade to a Buy. Target Price (PLN) 81.0 We cut our 12M TP for Handlowy to PLN 81 from PLN 86 previously, but due to share Market Price (PLN) 67.0 price drop we upgrade the stock to a Buy from Neutral. On the back of 1Q18 results Upside/downside 21% Previous rating Neutral we increased our 2018E EPS estimates by 4%, but to reflect changes in expected Previous Target Price (PLN) 86.0 interest rates hikes we cut our 2019E forecasts by 3%. We see 5 reasons that make Min (52W) 62.1 Handlowy attractive, in our view: 1) it is attractively valued – at 1YF P/E Handlowy is Max (52W) 81.3 Market cap (PLNm) 8,754 trading with 17/18% discount to 1/3Y average, 2) it may appear to be the last (and only) high yielding bank in Poland, 3) it offers the second best EPS growth in 2018E Shareholders % (24% YoY), 4) it is free of CHF-related risk, 5) While downside risks are limited, we see Citibank Overseas 75.0% Other 25.0% an upside risk coming from faster than currently expected interest rates hikes. Changes to 2018E and 2019E estimates. On the back of 4Q17 and 1Q18 results we lift Company description Handlowy is a universal bank in Poland with our 2018E adjusted earnings estimates by 4% (to PLN 655m). To reflect changes in 2.5% market share in assets, c. 2% in loans and expected interest rate hikes (we now assume 25bp hike in 4Q19 vs. 2x25bp in 3/4Q18 2.5% in deposits. Corporate loans stand for over 60% of the bank’s loan book and retail previously) we cut our 2019E adjusted earnings estimates by 3% (to PLN 717m). Our loans are dominated by consumer lending (c. 2018/19E forecast are 2% above and 1% below consensus, respectively. 30% of the loan book, incl. 14% in credit cards). PLN denominated mortgage loans stand for 8% Second best EPS growth among Polish banks in 2018E. In 2017 Handlowy’s adjusted net of the bank’s book. At the end of 1Q18 profit was 3% down YoY due to rising provisions, higher costs and lower financial income. Handlowy had 24 branches. However, in 2018E we expect Handlowy to see the second-best EPS growth (+24% YoY) Handlowy vs. WIG vs. WIG Banks 12M among 9 banks in our coverage supported by rising NII (7% YoY), lower provisions (-34% relative price performance rebased YoY) and higher financial and other income (+9% YoY). We note, that while in 1Q18 100 Handlowy reported very strong AFS gains, solid financial result and low provisions, we do not expect the numbers to be repeated in the following quarters. 90 80 The last (and only) high-yielding bank in Poland? After paying 100% of 2017 earnings as a dividend we expect Handlowy to continue its dividend policy over the next years 70 and from 2018 earnings expect DPS PLN 5.0 and DY 7.5%. While we assume a decent 60 payout also in Pekao (DY 7.3%), the bank’s dividend policy may be changed if it decides cze 17 wrz 17 gru 17 mar 18 to take an advantage of M&A opportunities. BHW WIG WIG Banki Valuation attractive in relative and historical terms. At our estimates Handlowy is Source: Bloomberg, Vestor DM trading at 13.4x 2018E P/E and 1.24x P/BV, in line with peers. Given high dividend yield, strong EPS growth and no regulatory (CHF) risk, we see the bank’s valuation as attractive.

We note, that Handlowy is trading with 17/18% discount to 1/3Y average at 1YF P/E and with 10/11% discount at 1YF P/BV. Figure 1. Handlowy – Key data, 2015-2020E

2015 2016 2017 2018E 2019E 2020E

Net profit (PLNm) 626 602 536 664 717 787 YoY change (%) -34% -4% -11% 24% 8% 10% Adjusted net profit (PLNm) 679 544 527 655 717 787 YoY change (%) -28% -20% -3% 24% 10% 10%

ROE adjusted (%) 9.5% 8.0% 7.7% 9.3% 10.1% 11.0% Michał Fidelus P/E adjusted (x) 12.9 16.1 16.6 13.4 12.2 11.1 Head of Research P/BV (x) 1.28 1.29 1.26 1.24 1.23 1.21 (+48) 22 378 9212 DPS (PLN)* 4.7 4.5 4.1 5.0 5.4 6.0 [email protected] DY (%)* 7.0% 6.8% 6.1% 7.5% 8.1% 8.9% * from the year’s earnings. Source: Company data, Vestor DM estimates

All prices are those current at the end of June 19, 2018,17:30 unless otherwise indicated. Prices are sourced from local exchanges via Reuters, Bloomberg and other vendors. Data is sourced from Vestor DM and subject companies. Investors should consider this report as only a single factor in making their investment decision. This document is an investment research within the meaning of article 36.1 Commission Delegated Regulation (EU) 2017/565 of 25 April 2016 supplementing Directive 2014/65/EU of the European Parliament and of the Council as regards organizational requirements and operating conditions for investment firms and defined terms for the purposes of that Directive.

Handlowy | June 2018

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This report has been prepared by Vestor Dom Maklerski S.A. (“Vestor”), with its registered office in Warsaw, al. Jana Pawła II 22, 00-133 Warsaw, registered by the District Court for the capital city Warsaw, XII Commercial Division of the National Court Register under the number KRS 0000277384, Taxpayer Identification No. 1080003081, with share capital amounting to PLN 1 811 570 fully paid up, entity that is subject to the regulations of the Act on Trading in Financial Instruments dated July 29th 2005 (Journal of Laws of 2017, item 1768 - consolidated text, further amended), Act on Public Offering, Conditions Governing the Introduction of Financial Instruments to Organised Trading, and Public Companies dated July 29th 2005 (Journal of Laws of 2016, item 1639 consolidated text, further amended), Act on Capital Market Supervision dated July 29th 2005 (Journal of Laws of 2016 item 1289 consolidated text, further amended).

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Page | 10 Handlowy | June 2018

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Over the last three months, excluding recommendation contained in this report, Vestor issued 5 Buy recommendations, 0 Accumulate recommendations, 4 Neutral recommendations, 1 Reduce recommendation and 0 Sell recommendations. In addition to the above, Vestor DM issued 6 recommendations without pointing the investment direction or target price, including 5 acting within the Equity Research Partner commercial publications within the meaning of art. 36 par. 2 of Commission Delegated Regulation (EU) 2017/565 of 25 April 2016 supplementing Directive 2014/65 / EU of the European Parliament and of the Council with regard to organizational requirements and operating conditions of investment firms and concepts defined for the purposes of this directive, which do not indicated the investment direction. The proportion of issuers number corresponding to each of the above directions of recommendation, for which Vestor has rendered investment banking services within last 12 months is 31%.

THE LAST RECOMMENDATION ISSUED TO THE COMPANY BANK HANDLOWY S.A. WAS PUBLISHED ON THE 8rdOF JANUARY 2018 AND INCLUDED A NEUTRAL RECOMMENDATION.

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Vestor has adopted "Procedure of managing conflicts of interest in Vestor Dom Maklerski SA", which defines the procedure for the prevention and effective management of conflicts of interest by eliminating the risk of the possible damage relating to interest of the customer, as well as specify the means and procedures for managing such conflicts of interest. Responsibilities in the matter of prevention, management and monitoring in the event of a conflict of interest are performed by designated organizational entity whose employees have the following tools that ensure proper execution of these tasks: (i) access to all documents of both the Company and the subsidiary company, (ii) the right to request provide explanations for all employees, (iii) the ability to analyze own transactions concluded by the Related persons.

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Note on what the evaluation of equities is based:

Buy/Accumulate/Neutral/Reduce/Sell – means that, according to the authors of this document, the stock price may perform materially better/better/neutrally/worse/materially worse than the cost of equity of the respective stock.

The recommendation system of Vestor is based on determination of target prices and their relations to current prices of financial instruments; in addition, when recommendations are addressed to a wide range of recipients, two methods of valuation are required.

In preparing this document Vestor applied at least two of the following valuation methods:

1) Discounted cash flows (DCF),

2) Comparative valuation (including ROE-p/BV model),

Page | 11 Handlowy | June 2018

3) Target multiple,

4) Scenario analysis,

5) Dividend discount model (DDM),

6) net asset value (NAV),

7) Sum of the parts,

8) Discounted residual income model (DRIM),

9) Risk-adjusted net present value (rNPV).

The discounted cash flows valuation method (DCF) is based on discounted expected future cash flows. The method includes all cash flows the issuer is expected to generate in a given period and the cost of money over time. However, the DCF valuation method requires a number of assumptions and is very sensitive to changes in parameters used in the in the model. Small changes in assumptions may result in material changes in the valuation.

The comparative valuation method is based on the rule of “one price”. The advantages of the method include 1) a small number of parameters to be estimated, 2) the fact that there is a relatively large number of indicators for companies being compared, 3) The method is well-known among investors, 4) valuation is based on current market conditions. On the other hand, a comparative valuation is strongly sensitive to the valuation of the companies classified as peers and may lead to a simplified picture of the company valued.

The target multiple valuation approach is based on the assumption that the value of the company should be equal to pre-specified values of selected price multiples. The advantage of this method is its simplicity and applicability to almost all of the companies. The target multiple approach is a highly subjective method, though.

The scenario analysis approach is based on the probability weighted valuation for three sets of assumptions: Bear case , base case and bull case with a different probability assigned. The base case is based on the assumptions included in financial forecasts and DCF valuation. The bear/bull case scenarios present a sensitivity towards negative/positive changes in various assumptions including market size, market shares, profitability, growth, capex, valuation multiples etc. The advantage of this method is presentation of various scenarios and valuation sensitivity. A complexity and sensitivity to probability weights assumption may be found as disadvantages.

The dividend discount model (DDM) valuation is based on discounted future dividends that are expected to be paid out by the company over a period of time. The DDM model includes real cash streams that are expected to be received by shareholders and may be applied to companies with long-term dividend payout history. However, the DDM valuation method requires a number of assumptions.

The net asset value (NAV) approach considers the underlying value of the company’s individual assets net of its liabilities. Among the advantages of the NAV approach are its applicability to asset holding companies and the fact that data required are usually easy to reach. On the other hand the NAV approach does not take into account future changes in revenues or income and can underestimate the value of intangible assets.

The sum of the parts approach values a company on the back of valuations of its separate divisions. The method is applicable to companies with very different business profiles, but requires identification of peers for business divisions comparison, what may be difficult to achieve.

The discounted residual income model includes equity at the end of a given financial year, excess equity (return on equity over cost of equity) the company is expected to generate in the estimation period and a discounted residual value post-estimation period. On one hand, the method includes profitability of the company compared to a cost of equity, but on the other hand it is strongly dependent on a number of parameters and assumptions.

The risk-adjusted net present value (rNPV) is a method used to forecast future cash flows in high-risk projects. In biotechnology, rNPV method involves forecasting future cash flows and applying probability rates of different phases of drug development. The main advantage of this method is the fact that it takes into account probability of success. The disadvantage of this method is the large number of assumptions and the high level of computational complexity.

Terminology used in the recommendation:

P/E – price-earnings ratio

PEG - P/E to growth ratio

EPS - earnings per share

P/BV – price-book value

BV – book value

EV/EBITDA – enterprise value to EBITDA

EV – enterprise value (market capitalization plus net debt)

EBITDA – earnings before interest, taxes, depreciation, and amortization

EBIT – earnings before interest and tax

NOPAT – net operational profit after taxation

FCF - free cash flows

ROE – return on equity

WACC - weighted average cost of capital

CAGR – cumulative average annual growth

CPI – consumer price index

COE – cost of equity

L-F-L – like for like

Recommendation definitions:

Buy - indicates a stock's total return to exceed more than 1.5x respective cost of equity over the next twelve months.

Accumulate - indicates a stock's total return to exceed more than respective cost of equity over the next twelve months.

Neutral - indicates a stock's total return to be in range of 0% to respective cost of equity over the next twelve months.

Reduce - indicates a stock's total return to be in range of minus respective cost of equity to 0% over the next twelve months.

Sell - indicates a stock's total return to be less than minus respective cost of equity over the next twelve months.

ANY PERSON WHO ACCEPTS THIS DOCUMENT AGREES TO BE BOUND BY THE FOREGOING DISCLAIMER AND LIMITATIONS.

List of all recommendations issued by Vestor in the last 12 months:

Page | 12 Handlowy | June 2018

No. Company Recommendation Analyst TP Current price at the time Recommendation Time horizon Date of publication of the recommendation 36/2017 Warimpex 2017-05-29 Marek Szymański 5.66 5.11 Not rated 12M 37/2017 Kruk 2017-06-02 Michał Fidelus 316.0 300.9 Neutral 12M 38/2017 Vigo System 2017-06-12 Beata Szparaga-Waśniewska 468 372 Not rated 12M 39/2017 Ciech 2017-06-13 Katarzyna Włodarczyk 72.3 65.4 Neutral 12M 40/2017 Wawel 2017-06-14 Marcin Stebakow 1368.0 1175 Buy 12M 41/2017 Colian 2017-06-30 Marcin Stebakow 3.48 3.50 Not rated 12M 42/2017 Marvipol 2017-07-13 Marek Szymański 18.0 12.7 Not rated 12M 43/2017 PKO BP 2017-07-24 Michał Fidelus 34.0 35.8 Reduce 12M 44/2017 Pekao 2017-07-24 Michał Fidelus 140.0 128.0 Accumulate 12M 45/2017 BZ WBK 2017-07-24 Michał Fidelus 349.0 362.5 Reduce 12M 46/2017 mBank 2017-07-24 Michał Fidelus 380.0 460.0 Sell 12M 47/2017 ING BSK 2017-07-24 Michał Fidelus 191.0 189.0 Neutral 12M 48/2017 Handlowy 2017-07-24 Michał Fidelus 71.0 68.1 Neutral 12M 49/2017 Millennium 2017-07-24 Michał Fidelus 7.1 7.5 Reduce 12M 50/2017 Alior 2017-07-24 Michał Fidelus 68.0 60.5 Accumulate 12M 51/2017 Getin Noble Bank 2017-07-24 Michał Fidelus 1.58 1.45 Neutral 12M 52/2017 Grupa Azoty 2017-07-28 Katarzyna Włodarczyk 75.0 67.6 Accumulate 12M 53/2017 JSW 2017-08-09 Marcin Stebakow 102.0 90.5 Buy 12M 54/2017 Ciech 2017-08-10 Katarzyna Włodarczyk 68.0 62.5 Neutral 12M 55/2017 Lotos 2017-08-21 Beata Szparaga-Waśniewska 56.0 51.0 Neutral 12M 56/2017 Getback 2017-08-25 Michał Fidelus 26.6 21.8 Accumulate 12M 57/2017 KGHM 2017-08-28 Marcin Stebakow 153.0 126.0 Buy 12M 58/2017 Wawel 2017-08-30 Marcin Stebakow 1153 990 Buy 12M 59/2017 Mercator Medical 2017-09-07 Aleksandra Jakubowska 23.1 18.0 Not rated 12M 60/2017 Kruk 2017-09-14 Michał Fidelus 340.0 311.0 Accumulate 12M 61/2017 Bogdanka 2017-09-21 Marcin Stebakow 95.0 78.0 Buy 12M 62/2017 JSW 2017-09-28 Marcin Stebakow 107 93 Buy 12M 63/2017 MZN Property 2017-10-04 Aleksandra Jakubowska 2.0 1.45 Not rated 12M 64/2017 Warimpex 2017-10-11 Marek Szymański 7.3 6.73 Not rated 12M 65/2017 ATC Cargo 2017-10-13 Marcin Stebakow 3.0 2.0 Not rated 12M 66/2017 LPP 2017-10-19 Marek Szymański 6962.0 7960.0 Sell 12M 67/2017 CCC 2017-10-19 Marek Szymański 322.0 265.3 Buy 12M 68/2017 PKO BP 2017-10-24 Michał Fidelus 35.0 36.7 Reduce 12M 69/2017 Pekao 2017-10-24 Michał Fidelus 139 125.2 Accumulate 12M 70/2017 BZ WBK 2017-10-24 Michał Fidelus 370 356 Neutral 12M 71/2017 mBank 2017-10-24 Michał Fidelus 393 452.5 Reduce 12M 72/2017 ING BSK 2017-10-24 Michał Fidelus 193 191.2 Neutral 12M 73/2017 Handlowy 2017-10-24 Michał Fidelus 75.0 70.0 Neutral 12M 74/2017 Millennium 2017-10-24 Michał Fidelus 7.7 7.55 Neutral 12M 75/2017 Alior Bank 2017-10-24 Michał Fidelus 80.0 70.2 Buy 12M 76/2017 Getin Noble 2017-10-24 Michał Fidelus 1.40 1.53 Reduce 12M 77/2017 Marvipol 2017-10-24 Marek Szymański 19.0 13 Not rated 12M 78/2017 KGHM 2017-11-23 Marcin Stebakow 134 114.25 Buy 12M 79/2017 JSW 2017-11-29 Marcin Stebakow 86.8 90.2 Reduce 12M 80/2017 Vigo System 2017-12-05 Beata Szparaga-Waśniewska 455 305 Not rated 12M 81/2017 LW Bogdanka 2017-12-07 Marcin Stebakow 75 95 Accumulate 12M 82/2017 Śnieżka 2017-12-08 Aleksandra Jakubowska 63 69 Not rated 12M 83/2017 Dom Development 2017-12-14 Marek Szymański 90 83.4 Accumulate 12M 84/2017 Atal 2017-12-14 Marek Szymański 43 41.0 Neutral 12M 85/2017 LC Corp 2017-12-14 Marek Szymański 3.3 2.7 Buy 12M 86/2017 Robyg 2017-12-14 Marek Szymański 4.1 3.5 Accumulate 12M 87/2017 Lokum Deweloper 2017-12-14 Marek Szymański 23 16.55 Buy 12M 88/2017 Archicom 2017-12-14 Marek Szymański 23 15.39 Not rated 12M 1/2018 PKO BP 2018-01-08 Michał Fidelus 45 44.3 Neutral 12M 2/2018 Pekao 2018-01-08 Michał Fidelus 152 134.3 Buy 12M 3/2018 BZ WBK 2018-01-08 Michał Fidelus 442 408.4 Accumulate 12M 4/2018 mBank 2018-01-08 Michał Fidelus 443 496 Sell 12M 5/2018 ING BSK 2018-01-08 Michał Fidelus 222 215 Neutral 12M 6/2018 Handlowy 2018-01-08 Michał Fidelus 86 83 Neutral 12M 7/2018 Millenium 2018-01-08 Michał Fidelus 8.9 9.4 Reduce 12M 8/2018 Alior 2018-01-08 Michał Fidelus 87 78 Accumulate 12M 9/2018 Getin Noble Bank 2018-01-08 Michał Fidelus 1.55 1.71 Reduce 12M 10/2018 PKN 2018-01-09 Beata Szparaga-Waśniewska 117 106.7 Neutral 12M 11/2018 Lotos 2018-01-09 Beata Szparaga-Waśniewska 54 57.4 Reduce 12M 12/2018 PKP Cargo 2018-02-14 Marcin Stebakow 68 58.8 Buy 12M 13/2018 BZ WBK 2018-02-21 Michał Fidelus 436 385.8 Buy 12M 14/2018 Wielton 2018-02-23 Marcin Górnik 15.3 12.36 Buy 12M 15/2018 Selvita 2018-03-20 Beata Szparaga-Waśniewska 85 59 Not rated 12M 16/2018 JSW 2018-03-22 Marcin Stebakow 99 95.3 Neutral 12M 17/2018 Marvipol Development 2018-03-26 Marek Szymański 8.9 8.7 Not rated 12M 18/2018 Kruk 2018-03-28 Michał Fidelus 286 208 Buy 12M 19/2018 British Automotive Holding 2018-03-28 Marek Szymański 10.5 8.3 Not rated 12M 20/2018 Aplisens 2018-04-04 Michał Wojciechowski 15.1 12.9 Buy 12M 21/2018 Wielton 2018-04-05 Marcin Górnik 16.0 13.7 Buy 12M 22/2018 KGHM 2018-04-16 Marcin Stebakow 110.0 92.0 Buy 12M 23/2018 LPP 2018-04-18 Marek Szymański 9000 8965 Neutral 12M 24/2018 CCC 2018-04-18 Marek Szymański 310 272 Buy 12M 25/2018 mBank 2018-04-19 Michał Fidelus 441 439 Neutral 12M 26/2018 AC 2018-04-23 Marcin Górnik 38.5 40.8 Reduce 12M 27/2018 MZN Property 2018-05-08 Aleksandra Jakubowska 2.2 1.9 Not Rated 12M 28/2018 Pekao 2018-05-16 Marcin Górnik 148 118,7 Buy 12M 29/2018 Archicom 2018-05-24 Marek Szymański 23.0 15.9 Not Rated 12M 30/2018 PKO BP 2018-05-25 Michał Fidelus 42.0 38.9 Neutral 12M 31/2018 Warimpex 2018-05-28 Marek Szymański 8.3 6.0 Not Rated 12M

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